The funds in your HSA may be taxable income to the beneficiary.
One of the benefits of a high-deductible health insurance plan is the health savings account, or HSA, that you can open to pay for qualified medical expenses. The balance in an HSA can roll over from year to year, and there isn't a cap on the amount you can accrue in an HSA. The IRS doesn't restrict who you name as the beneficiary of your HSA, but the tax consequences vary based on your relationship to the beneficiary.
Designating Your Spouse as the Beneficiary
When your spouse is the designated beneficiary of your HSA, the IRS treats the HSA as if your spouse was the original owner. That means that the funds in the HSA can be used by your spouse for qualified medical expenses without paying taxes on the withdrawals. Your spouse can also use these funds to pay any outstanding qualified medical expenses you may have without any income tax liability.
Nonspousal Beneficiary
If anyone other than your spouse is the designated beneficiary of your HSA --- including your estate --- the account is no longer treated as an HSA. As a result, "the fair market value of your HSA becomes taxable income to the beneficiary for the year in which you die," according to IRS Publication 969.
Reducing Taxable Income From an HSA
The only way that a nonspousal beneficiary can reduce the taxable income that results from inheriting an HSA is to pay qualified medical expenses incurred by the decedent. To reduce the taxable income, the beneficiary may not be the estate of the deceased, and the expenses must be paid within one year of the death of the original HSA owner. If the beneficiary is the decedent's estate, paying qualified medical expenses doesn't reduce the taxable income.
Keeping Beneficiaries Informed
If the nonspousal beneficiary of your HSA doesn't have an HSA, confirm that the executor of your estate is aware of the ability to reduce the taxable income of the HSA by paying your remaining qualified medical expenses.
Tags: medical expenses, qualified medical, qualified medical expenses, taxable income, beneficiary your
